Reviewed by the CoveragePrep editorial team · Sources: state insurance departments, statutes, exam candidate handbooks · How we research
Practice test · 25 questions
Insurance Basics and Contract Law Practice Test (Part 1 of 2)
Every adjuster exam opens with the same foundation: what makes a risk insurable, how an insurance contract is formed, and which legal doctrines decide a disputed claim. These questions drill the vocabulary that the rest of the exam assumes you already know.
Expect definitions (peril versus hazard, aleatory versus adhesion), short scenarios about misrepresentation, waiver and estoppel, and questions about how policies are organized from the declarations to the endorsements.
Questions
25
Suggested time
30 min
Difficulty mix
11 / 11 / 3
Passing target
70%
What these questions cover
Pure and speculative risk, perils, physical, moral and morale hazards
Elements of a contract and the special features of insurance contracts
Representations, warranties, concealment, waiver and estoppel
Declarations, insuring agreements, conditions, exclusions and endorsements
Stock, mutual and reciprocal insurers, admitted and surplus lines carriers, agency authority
Indemnity, insurable interest, subrogation and other-insurance clauses
A county requires Ridgeline Paving to furnish a performance bond before starting a road project, and a surety company issues the bond. In this surety bond, which party is the obligee?
Show answer and explanation
Correct answer: A. The county that requires the bond and is protected by it
A surety bond has three parties. The principal (here, the contractor) owes the underlying obligation; the obligee (the county) requires the bond and is protected if the principal fails to perform; and the surety guarantees the principal's performance to the obligee. In a construction contract bond, the project owner is usually the obligee. The contractor's other insurers are not parties to the bond.
How does a surety's expectation of loss on a contract bond typically differ from a property or liability insurer's expectation of loss on its policies?
Show answer and explanation
Correct answer: B. The surety expects no losses, because it prequalifies the principal
An insurer pools premiums from many insureds and expects to pay a predictable volume of losses. A surety underwrites more like a lender: it examines the principal's credit, financial strength, experience, and capacity, and issues the bond expecting the principal to perform, so it does not expect to suffer losses. If it does pay, the principal and other indemnitors must reimburse it under an indemnity agreement.
Summit Builders, the principal on a performance bond, defaults on a school project. The surety spends $180,000 to have another contractor finish the work and $20,000 on investigation and legal expenses. Summit and its owners signed a general indemnity agreement. How much may the surety seek from them?
Show answer and explanation
Correct answer: D. $200,000
Unlike an insurer, a surety looks to the principal for repayment. A general indemnity agreement obligates the named indemnitors, often the contractor and its owners, to protect the surety from any loss or expense it suffers from having issued the bond: $180,000 to complete the work plus $20,000 of expenses, or $200,000. The bond protects the obligee, not the principal, so Summit cannot treat the payment as its own insured loss.
Delta Mechanical submits the low bid on a public hospital project and is awarded the contract, but it then refuses to sign the contract or furnish the required performance and payment bonds. Which bond protects the project owner in this situation?
Show answer and explanation
Correct answer: A. The bid bond
A bid bond protects the owner if a bidder is awarded the contract but fails to sign it or to provide the required performance and payment bonds. SBA regulations define it as a bond conditioned on the bidder entering into the contract and furnishing those bonds. Performance and payment bonds take effect only after the contract is signed, and a maintenance bond covers defects during a warranty period.
Halfway through building a county library, the general contractor abandons the job because of financial trouble. Which bond gives the county a guarantee that the surety will complete the project or cause it to be completed?
Show answer and explanation
Correct answer: B. The performance bond
A performance bond guarantees the owner that, if the contractor defaults, the surety will complete the contract or cause it to be completed, for example by financing the contractor, hiring a replacement, or paying the owner as the bond provides. A payment bond protects subcontractors and suppliers, a bid bond applies only at the bidding stage, and a license bond guarantees compliance with licensing laws.
On a federal courthouse renovation, the prime contractor fails to pay an electrical subcontractor and a lumber supplier for labor and materials they furnished. Which bond is designed to protect them?
Show answer and explanation
Correct answer: C. The payment bond, which protects labor and material suppliers
A payment bond guarantees that certain subcontractors and suppliers will be paid for labor and materials furnished for the project. Under 40 U.S.C. 3131(b), the federal payment bond protects all persons supplying labor and material in carrying out the work, and 40 U.S.C. 3133 lets unpaid claimants sue on the bond. The performance bond protects the owner's interest in having the work completed.
A city accepts a newly built water treatment plant. Eight months later, during the contract's warranty period, defective workmanship causes a pump housing to crack. Which contract bond guarantees the owner that such defects will be repaired?
Show answer and explanation
Correct answer: A. The maintenance bond
A maintenance bond, also called a warranty bond, guarantees the owner that defects in workmanship and materials found in the original construction will be repaired during the warranty period. It extends protection past completion, when the performance bond's main purpose has been met. The SBA groups it among ancillary bonds, which cover requirements outside performance and payment, such as maintenance.
Under FAR 28.102-1, which implements the federal bonds statute formerly known as the Miller Act, performance and payment bonds are required for federal construction contracts exceeding what amount?
Show answer and explanation
Correct answer: C. $150,000
FAR 28.102-1(a) requires performance and payment bonds for any federal construction contract exceeding $150,000, subject to limited waivers such as work performed in a foreign country. The underlying statute, 40 U.S.C. 3131, states a $100,000 figure that the FAR has adjusted for inflation. For contracts over $35,000 up to $150,000, the contracting officer instead selects alternative payment protections, such as a payment bond or an irrevocable letter of credit.
Cruz Supply sold drywall to a subcontractor, not to the prime contractor, on a federal project bonded under the Miller Act. Its last delivery was March 10, and it has not been paid. To claim on the prime contractor's payment bond, by what date must it give the prime contractor written notice?
Show answer and explanation
Correct answer: C. June 8
Under 40 U.S.C. 3133(b)(2), a claimant that contracted with a subcontractor but has no contract with the prime contractor must give the prime contractor written notice within 90 days after the last labor or material it furnished, and 90 days after March 10 is June 8. The notice must state the amount claimed with substantial accuracy. Any suit on the payment bond must be filed within one year after the last labor or material was supplied, in federal district court in the name of the United States.
To get a state license, a public insurance adjuster must file proof of financial responsibility, such as a surety bond, that can pay judgments won by insureds harmed by the adjuster's errors, fraud, or unfair practices. This is an example of which kind of bond?
Show answer and explanation
Correct answer: B. A license and permit bond
License and permit bonds are commercial surety bonds that a government requires before granting a license or permit. They guarantee that the licensee will comply with the laws governing the activity and protect the public against fraud, misrepresentation, and financial harm. The licensee is the principal and the licensing government is the obligee. Texas, for example, requires public adjusters to maintain financial responsibility under Insurance Code Sec. 4102.105.
A probate court appoints Nadia Haddad as administrator of her late uncle's estate and requires her to post a bond conditioned on administering the estate faithfully and not wasting or misapplying its assets. What type of bond is this?
Show answer and explanation
Correct answer: D. A fiduciary (probate) bond
Court bonds are divided into judicial bonds, which arise from litigation, and fiduciary (probate) bonds, which guarantee that people a court has entrusted with others' property, such as executors, administrators, guardians, and trustees, will perform their duties faithfully. For example, Texas Estates Code Sec. 305.101 generally requires a person receiving letters of administration to give bond first, and Sec. 305.106 makes it payable to the judge.
Court bonds are often divided into judicial bonds and fiduciary bonds. Which of these is a judicial bond rather than a fiduciary bond?
Show answer and explanation
Correct answer: A. An appeal bond securing a judgment during an appeal
SFAA describes judicial bonds as bonds required when litigants seek court remedies or privileges that the law allows only if a bond protects the opposing party; examples include injunction, appeal, attachment, and replevin bonds. An appeal bond protects the winning party if the appeal fails. Bonds for guardians, executors, administrators, and trustees are fiduciary bonds guaranteeing faithful handling of property under court supervision.
Before taking office, a county treasurer must execute a bond with a surety company, conditioned on faithfully performing the duties of the office. This is an example of:
Show answer and explanation
Correct answer: B. A public official bond
A public official bond guarantees the honesty and faithful performance of a person elected or appointed to a position of public trust, such as a treasurer, tax collector, sheriff, or court clerk. The official is the principal, and the government and the public it serves are protected. Texas Local Government Code Sec. 83.002, for instance, requires a county treasurer to execute a bond with a surety company, conditioned that the treasurer will faithfully execute the duties of office.
How does a modern fidelity bond, also called employee dishonesty coverage, differ from a surety bond?
Show answer and explanation
Correct answer: C. It is a two-party contract protecting the employer against employee dishonesty
Fidelity bonds were originally written as three-party surety bonds guaranteeing an employee's honesty, but today they are two-party insurance contracts between the employer and the insurer, often called employee dishonesty, commercial crime, or financial institution bonds. They reimburse the employer for losses such as theft, embezzlement, and forgery by its employees. A surety bond, by contrast, involves a principal, an obligee, and a surety.
A union pension plan's ERISA fidelity bond is canceled, and six months later the plan discovers that an administrator embezzled funds while the bond was in force. Under 29 CFR 2580.412-19(b), what minimum discovery period after cancellation must an ERISA bond generally provide?
Show answer and explanation
Correct answer: D. One year
29 CFR 2580.412-19(b) requires a discovery period of no less than one year after a bond is terminated or canceled, so a loss that occurred during the bond term and is found six months later falls within that window. One exception: a form written on a discovery basis may instead give the insured the right to buy a one-year discovery period, if the insured has told the surety it wants one.
Which situation is an example of pure risk, the type of risk that private insurers are generally willing to insure?
Show answer and explanation
Correct answer: B. Owning a warehouse that may or may not be damaged by fire
Pure risk offers only the chance of loss or no loss, with no chance of gain. A warehouse owner either suffers a fire loss or does not, which makes the exposure insurable. Stocks and a new restaurant are speculative risks because they can produce a gain as well as a loss, and a wager is a speculative risk the bettor chooses to create.
In insurance terminology, which of the following is a peril rather than a hazard?
Show answer and explanation
Correct answer: C. Lightning
A peril is the cause of a loss, such as lightning, fire, windstorm, or theft. A hazard is a condition that increases the chance or severity of a loss from a peril. Frayed wiring and oily rags are physical hazards, and careless candle use is a morale hazard. Each makes a fire more likely, but none is itself the cause of loss.
After adding comprehensive coverage to her auto policy, Priya starts leaving her car unlocked with the keys inside, reasoning that her insurer will pay if it is stolen. Which type of hazard does her attitude represent?
Show answer and explanation
Correct answer: C. Morale hazard
Morale hazard is carelessness or indifference to loss that arises because a person has insurance. Priya is not planning to fake a theft or cause a loss on purpose, which would be moral hazard, a matter of dishonesty. Her indifference simply makes a theft more likely. A physical hazard is a tangible condition, such as worn brakes or faulty wiring.
Which term describes any condition or situation that presents the possibility of loss, whether or not a loss actually occurs?
Show answer and explanation
Correct answer: D. Loss exposure
A loss exposure is the possibility of loss, and it exists even if no loss ever happens. A property loss exposure has three elements: an asset exposed to loss, a cause of loss, and the financial consequences of that loss. A peril is the cause of loss itself, and a hazard is a condition that makes a loss more likely or more severe.
A small manufacturer considers adding a line of backyard trampolines. After studying the potential for severe injury lawsuits, management decides not to make trampolines at all. Which risk management technique has the company used?
Show answer and explanation
Correct answer: B. Avoidance
Avoidance eliminates a loss exposure by not taking on the activity that creates it, so the company will have no product liability exposure from trampolines. Reduction would mean making the product but lowering loss frequency or severity, such as adding safety netting. Retention means paying losses with the company's own funds, and transfer shifts the financial burden to another party, such as an insurer.
Which principle holds that as the number of similar, independent exposure units increases, an insurer's actual losses will more closely match its expected losses?
Show answer and explanation
Correct answer: B. Law of large numbers
The law of large numbers states that as a sample grows, the relative variation around the average declines. By pooling many similar exposures, an insurer can predict losses accurately enough to set adequate premiums. Adverse selection is the tendency of higher-risk applicants to seek coverage, and indemnity concerns restoring the insured to the pre-loss financial position.
An insurer offering optional flood coverage finds that nearly all buyers live in low-lying areas near rivers, while few owners on higher ground buy it. Which concept does this pattern illustrate?
Show answer and explanation
Correct answer: C. Adverse selection
Adverse selection is the tendency of people with higher-than-average chances of loss to seek or keep insurance more often than those with lower chances. If premiums assume an average risk, the insurer collects too little. Underwriting, risk classification, and policy provisions help control it. Moral hazard concerns an insured's dishonesty, not who chooses to buy coverage.
Each of the following is an ideal characteristic of an insurable risk EXCEPT
Show answer and explanation
Correct answer: D. Exposure to a catastrophe that could strike most insureds at once
An insurable risk should not expose a large share of insureds to loss from one event, because a catastrophe could exceed the premiums collected and threaten the insurer's solvency. That is why perils such as flood and war are commonly excluded or handled through government programs. A large number of similar units, accidental losses, and definite, measurable losses are all ideal characteristics.
What is the main purpose of the principle of indemnity in property insurance contracts?
Show answer and explanation
Correct answer: C. To restore the insured to about the same financial position as before the loss
Indemnity means the insurer pays no more and no less than the actual loss, so the insured is made whole but does not profit. Paying the full limit regardless of the loss would reward losses and invite fraud. Insurable interest, subrogation, actual cash value valuation, and other-insurance clauses all help enforce the indemnity principle.
Which of the following is NOT one of the essential elements of a legally binding contract?
Show answer and explanation
Correct answer: A. A notarized signature
A valid contract requires agreement through offer and acceptance, consideration from each party, competent parties, and a legal purpose. Notarization is not required, and many property and casualty contracts begin with an oral binder from an agent. Contracts made by intoxicated or mentally incompetent persons, or for an illegal purpose such as insuring contraband, are not enforceable.
Pick an answer and the correct choice appears with an explanation and the policy form, statute or FEMA document it comes from. Difficulty is labeled on each question: recall items test a definition, application items put the rule into a short claim scenario, and challenging items combine two rules or require a calculation.
Aim for at least 80% before moving on, since the real exam mixes these topics with state law under time pressure. When you are consistently above that line, take a full timed exam or the version for your state: Texas or Florida 6-20.